Business Posts

Customer Lifetime Value and Startup Growth

When it comes to assessing the effectiveness of your business’ marketing efforts, not all metrics are equally valuable. For startups, one metric that is particularly useful in measuring marketing effectiveness is customer lifetime value.

Customer lifetime value (CLV) indicates the average total revenue a business can reasonably expect a single customer to generate over the course of the business relationship. The longer a customer continues to purchase from a company, the greater their lifetime value becomes.

Understanding CLV can help a business answer these critical questions:

  • How much can we profitably spend on marketing and sales for customer acquisition?
  • How much should we spend on customer service to retain an existing customer?
  • Who are our most valuable customers and how can we better target this demographic for future sales?

Not all customers are equally valuable. For most businesses, specific types of customers can be identified as the most profitable. Assessing CLV allows the business owner to dedicate more resources toward the acquisition and retention of high-value customers–thereby increasing profits overall.

Without measuring CLV, a business might spend too much to acquire customers whose lifetime value simply isn’t worth the cost. By identifying the most valuable group of customers, the business can focus on providing customer service tailored to their needs to ensure they stick around long-term.

Depending on the data used, CLV can be historic or predictive. Historic CLV is the sum of all profits from a customer’s past purchases. This number is based on existing customer data from a specific time period. Considered a more complete method of assessing CLV, predictive CLV uses transaction history and behavioral patterns to determine the current value of a customer and to forecast how customer value will evolve with time. As more data are collected to include in this calculation, the value will become increasingly accurate.

There are several different ways to determine CLV. The most basic is to calculate the revenue earned from a customer minus the initial cost of acquiring them, as shown in Formula 1. The revenue from a customer is the average amount of revenue generated annually multiplied times the expected number of years of the life of that customer relationship. Customer acquisition cost (CAC) is the total cost of sales and marketing efforts, including associated property and equipment, needed to convince a customer to buy a product or service (see Formula 2). This basic formula arrives at lifetime value in its simplest definition – lifetime revenue minus costs.

Formula 1. Basic Customer Lifetime Value Calculation

CLV = (Annual revenue per customer * Customer relationship in years) – CAC

Formula 2. Customer Acquisition Cost

CAC = Total sales and marketing expenditures / Number of new customers

For example, if a company generates an average of $3,000 in annual revenue per customer with an average customer lifetime of 10 years and an average CAC of $3,000 per customer, then the CLV calculation might look like this:

CLV = ($3,000 * 10) - $5,000 = $25,000

Looking at CLV through this lens makes it easier to justify the sales and marketing budgets required to land new customers in the first place. Notice that the cost of acquisition is actually higher than the revenue generated in the first year, but when lifetime value is considered, the acquisition cost is much smaller.

The simple approach works best if a customer’s annual profit contribution remains somewhat consistent. For example, if a business runs on a subscription-based model with only one or two tiers, then each of its customers can be expected to provide a relatively stable source of revenue.

On the other hand, if a company’s annual sales per customer are not relatively flat, a more in-depth CLV equation is needed. This traditional version of the formula takes rate of discount into consideration to account for future customer retention discounts or other price adjustments. It also provides a more detailed understanding of how CLV can change over the years.

The traditional CLV calculation shown in Formula 3 is more complex and should only be used for precise valuation. It breaks down the individual costs and profits of each year. Calculating it requires the following pieces of information: average gross margin (in dollars) per customer lifespan, customer retention rate, and rate of discount.

Formula 3. Traditional Customer Lifetime Value Calculation

CLV = Gross margin * (Retention rate / [1+ Rate of discount – Retention rate])

To determine a customer’s dollar value of gross margin, calculate the basic CLV using Formula 1 and then multiply the result by the gross margin rate. Taking the final result from the first example above and assuming a gross margin rate of 30%, the gross margin in dollars per customer lifespan would be 25,000 * .30, or $7,500.

This traditional method of calculation allows for fluctuations in customer revenue over time, and each year is adjusted by a rate of discount to account for inflation, price incentives or special offers. (A rate of 10% is commonly used by subscription companies.) Retention rate is the percentage of customers who continue to be customers by making a purchase in successive periods.

Continuing with this example, assume customer retention rate is 88% and the rate of discount is 10%. Our calculation would look this:

CLV = 7,500 * (0.88 / [1 + 0.10 – 0.88]) = $30,000

Regardless of which equation is used, one of the most valuable applications of CLV is using it to frame a better understanding of the business’ CAC. The CAC-to-CLV ratio reveals a lot about the health of a startup’s business model. Many startups and small businesses struggle to grow because CAC is higher than the profit contributions of a customer’s single transaction. It may in fact be higher than the estimated CLV. A high CAC-to-CLV ratio may even lead to a startup’s early demise.

After calculating CLV, the business can focus on optimizing this ratio, by targeting specific target customer segments which offer the best CAC to CLV ratio. This will ensure that the business continues to grow profitably.

For more on these and other topics, consider registering for the NaperLaunch Academy Workshop series. In addition, business librarians, NaperLaunch coaches, and SCORE mentors are available for one-to-one mentoring sessions.

Tuesday, April 6, 2021 - 09:45

The Power of a Strategic Plan

Operating a business without a strategic plan is like piloting a boat without a rudder. The business might be going somewhere, but no one knows for sure where or why, or if it is a good destination. Strategic planning is the process of assessing where the business is now and setting a path for where the business will be at some point in the future. In setting that path, the strategic plan should consider specific goals and establish actions that will help accomplish those goals. A written strategic plan helps owners, investors, and employees identify and understand how best to respond to opportunities and challenges.

In this post we will identify specific parts of the planning process that a business owner can follow to prepare a written plan. It is important to involve as many of the business’ stakeholders as possible in this process to avoid any blind spots that an owner may otherwise miss. Getting a broader perspective always makes planning better.

Situational Analysis

The place to start is assessing the current situation. There are several tools for this analysis, including SWOT, PEST, PESTLE, scenario planning, and the Porter’s Five Forces framework. Perhaps the best known and most commonly used is the SWOT analysis, which invites a candid review of the strengths, weaknesses, opportunities, and threats of a business. PEST and PESTLE assess major external factors in a marketplace that might impact the business. PEST is an acronym that stands for political, economic, social, and technological factors; the PESTLE analysis includes two additional factors: legal and environmental. The Porter’s Five Forces analysis more specifically addresses potential competition in the marketplace. Scenario planning is just that, considering alternative scenarios that might arise and planning responses to each scenario.

As shown in Figure 1, the SWOT analysis is done in a quadrant format lining up internal (strengths and weaknesses) vs. external (opportunities and threats) situations along the vertical axis and helpful (strengths and opportunities) vs. harmful (weaknesses and threats) situations along the horizontal axis.

Figure 1. The SWOT Analysis Grid

The SWOT Analysis Grid

In this way stakeholders can see the analysis in a quick one-page summary. A completed SWOT analysis is displayed in Figure 2. In this example, a new business owner is considering opening an insurance agency and has used SWOT to evaluate the situation.

Figure 2. Completed SWOT Analysis Example
  • Solid reputation of insurer
  • Recognized leader in industry
  • Well-known name and vast promotional campaigns
  • Great location at major intersection
  • Online and toll-free customer service access for extended hours
  • New agency, short track record in local market
  • Small staff, limited sales experience
  • No existing customers means no renewal income, dependent on new business
  • Allstate took two significant rate increases in 5 months
  • Enhanced commission for startups ends quickly
  • Growing community–new homeowners, new move-ins needing new insurance coverage
  • Good economic growth in city and county
  • New location for an insurance agency
  • Owner’s ability to market for commercial business, not just personal insurance
  • Large network can become prospects or referral sources
  • Major insurance agencies already established in town
  • Low-cost insurers present
  • Current economic downturn–fewer new car purchases, etc.
  • Slightly depressed trade area in immediate neighborhood
  • Excessive costs for obtaining leads and marketing campaigns

This analysis prepares the owner and other stakeholders to consider a vision for the future of the business. From that view, specific goals can be identified that would help attain that vision; these goals then guide the day-to-day operational action plans required to make it all happen.

The VGOST Strategic Plan Format

One common and effective strategic plan format is called VGOST, an acronym that stands for Vision, Goals, Objectives, Strategies, and Tactics. After completion of a thorough situational analysis, the next step is to set a vision for the future of the business. The vision is what the business is expected to be within a certain time frame.

While a mission statement identifies the purpose of the business, or what it does and why, a vision statement identifies what the stakeholders want to make of the business. Another way to think of it is the direction of the business in terms of growth, improvement, or competitive position. It is a description of what the business will be as the goals and objectives in the plan are achieved.

Goals are broad statements of what needs to be achieved in order to attain the vision statement. These goals could be set in various categories of business operations, marketing, and sales.

Objectives are more targeted in nature than goals and must be measurable and based on a time period. There may be several objectives under the heading of a single goal, each of which support achievement of the larger goal. For example, a goal to grow the number of customers in a business might have a few specific objectives like attend 1 public event each week to grow a network of contacts, contact 20 new prospects each month, add 10 new customers per month, and visit 10 current customers each month and build relationships. Each of these objectives supports the goal to retain and grow new customers. Each is specific, can be measured, and has a time frame for accomplishment.

The action steps that are undertaken to achieve the objectives take the form of strategies or tactics. A strategy is a specific approach or method to doing business, whereas a tactic is a specific activity. Strategies supporting the objectives in our example might be to make prospecting calls during certain hours of each business day, or to work with certain associations or affiliated groups of potential customers. Some tactics that support these same objectives might be to place a marketing campaign ad on a social media site at a certain time every weekday or make 20 prospecting phone calls during certain hours each weekday.

In Figure 3, we have created a mock strategic plan using the format discussed above. Notice the hierarchical relationship between the strategies, tactics, objectives, and goals. The strategies and tactics make up the day-to-day activities of a business that support attainment of the stated measurable objectives. The objectives support achieving the goals, and all of these pieces support the overall vision for the business.

Each one of the strategies and tactics is assigned to a specific staff member who is responsible for attainment of the objectives and goals. This example is only a small part of a strategic plan, but it need not be overly complex. For a small- to medium-sized business, two or three goals and one or two objectives per goal are sufficient to maintain momentum toward the overall vision.

Figure 3. Sample Strategic Plan in VGOST Format

Goal #1: Grow customer base to 1,000 customers.

Objective #1 – Add 10 new customers per week by July 1, 2021.
Strategies and TacticsPoint PersonTarget Date
Execute a Facebook advertising campaign each quarter of the year and measure effectiveness rate.MeMar 31
Jun 30
Sep 31
Dec 31
Make 20 telemarketing or networking contacts by telephone each day and measure each week.Me and my staffOngoing

Objective #2 – Retain 90% of customers and encourage repeat purchases at a rate of at least 50% by September 1, 2021.
Strategies and TacticsPoint PersonTarget Date
Develop a customer service program to maintain frequent contact with existing customers to be implemented by 3Q 2021.MeSep 30
Build brand loyalty through a frequent user rewards program offering discounts after multiple purchases. Deliverable by 2Q 2021.StaffMar 31

Goal #2: Attain 1 million followers online.

Objective #1 – Create an attractive website that draws viewers’ attention and becomes listed on the first page of a search engine search for my keywords by January 30, 2021.
Strategies and TacticsPoint PersonTarget Date
Hire a superb web designer and set expected completion date in the service agreement by December 1, 2020. Finalize the project by January.CIO (me?)Jan 5
Track effectiveness and SEO impact, adjust action plan as needed.CEO (me?)Jan 31 and ongoing

Objective #2 – Execute a comprehensive online marketing campaign that steadily increases followers by 100 new followers each month of 2021.
Strategies and TacticsPoint PersonTarget Date
Execute a social media campaign that attracts visitors to the website. Include an email gathering feature to begin developing a list of potential customers.CMO (me?)Jan 5
Execute an email marketing campaign to expand audience and attain return visits to website.CMOFeb 15 and ongoing
Create a blog that provides valuable information to potential customer audience to attract frequent visitors.CMOMar 15 and ongoing

Our example here is focused on marketing. As stated above, a written strategic plan would likely include other areas of the business and would follow this same format of goals, objectives, etc. and ultimately identify who is responsible with target completion dates. This way, all stakeholders in the business understand the direction and vision. Management and employees can move in that direction together and meet the strategic vision the business owners established.

For more on these and other topics, consider registering for the NaperLaunch Academy Workshop series. In addition, business librarians, NaperLaunch coaches, and SCORE mentors are available for one-to-one mentoring sessions.

Monday, March 29, 2021 - 08:45

6 Invaluable Selling Skills

In the NaperLaunch Academy workshop series, participants learn principles known as Professional Selling Skills. This sales approach could also be called “need-satisfaction” selling. The foundation of the workshop was developed many years ago and is based on scientific observation and analysis of successful salespeople. It was discovered that all successful salespeople automatically perform these basic skills almost flawlessly every time they engage in a sales interaction.

Need-satisfaction selling is a learned process of asking customers questions in such a way that they reveal their needs so that a seller can “support” those needs with a statement of the benefits of a product or service. It is a systematic approach to sales that a seller (or business owner) can easily learn and follow. With practice it becomes second nature and sales effectiveness increases dramatically.

There are 6 basic skills used in this sales approach or process: opening, probing, supporting the need with a benefit statement, handling objections, the trial close, and closing.

  1. Opening
  2. The skill of opening a sales interaction focuses on two key goals: building rapport and setting the objectives of the interaction.

    At the beginning of every sales interaction, the seller should begin to build rapport with a customer. Rapport is built by showing interest in the customer and the customer’s needs. Getting to know a customer and understanding their situation should actually start before any meeting or call. Sellers should invest time in researching the potential customer to understand their needs and experiences. Effectively building rapport puts the seller in a position of trust with the customer.

    Setting objectives for the sales interaction involves clearly stating the purpose and the expected outcome. This only requires a brief statement of what is hoped to be gained by meeting; however, a seller can also confirm acceptance of the purpose and expected outcome by the customer. Starting this way also gives the customer the chance to express specific things they want to know about the product or service, which will be immensely useful to the seller. If there is no agreement on objectives, then the seller should seek a different objective of the call until there is agreement. For example, instead of expecting to obtain an order, the objective might be adjusted to informing the customer about an offering and obtaining a commitment for a follow-up interaction.

    Once the opening conversation has introduced the participants to one another, established some rapport, and confirmed the objectives, it is time to proceed.

  3. Probing
  4. The next skill is called probing, which simply means asking questions–but not just any questions. Sales probes are intended to help uncover specific customer needs. Answers to sales probes should reveal what the customer really wants or needs, and the best sales probes will help uncover needs that the seller’s offering can solve.

    There are two types of probes: open and closed. An open probe gets the customer speaking freely, preferably about their routines and challenges. This may reveal specific needs that can be solved by the seller’s offering. Closed probes are more focused questions that may be answered with a shorter response, possibly a single word–yes or no. Closed probes are used to confirm or clarify the seller’s understanding of what the customer has said; in particular, they are used to confirm a need.

    In a sales interaction, a seller’s listening skills are more important than their speaking skills. Sellers must listen carefully to hear what the customer reveals in terms of problems (needs) that the seller can solve. When such a need is uncovered and confirmed, it must be supported with a benefit statement.

  5. Supporting the Need with a Benefit Statement
  6. A benefit statement describes the value that the customer will receive when using the product. It should not describe a feature of the product or service; rather, it must focus on the benefits of that feature. It should answer the question: What does the customer get?

    The first part of the statement generally acknowledges the customer’s need. The second part describes the benefit of the seller’s offering. The statement must specifically address and solve the need the customer has revealed. Lastly, the benefit statement concludes with a closed probe to confirm customer recognition of the need and acceptance of the benefit statement.

    If, as shown in Fig. 1, the features of a seller’s coffee pot are its heavy-gauge stainless steel construction and special silicone seals, then the benefits of that coffee pot to the customer are its resistance to rust, breakage, and leaking.

    Figure 1. Features and benefits of a coffee pot

    Features and benefits of a coffee pot

    In this example, the benefit statement should acknowledge that the customer indicated a need for a coffee pot that is resistant to rust, breakage, or leaking. Then the seller would point out that the superior-quality construction of the coffee pot being offered is such that it actually resists rust, breakage, and leaking. The statement would end with a closed probe: “Does that sound like the kind of coffee pot that you are looking to put into your warehouses?”

    In a sales interaction, this 3-step process of probing, uncovering needs, and supporting needs with a benefit statement is repeated continuously until the customer either cannot identify any more needs or exhibits buying signals. Buying signals are responses that indicate customer interest; they are sometimes verbal expressions and other times detected only in customer body language. With mild buying signals, the seller might proceed to a trial close. When strong buying signals are obvious, then the seller should proceed to the close. However, most of the time, some type of customer objection will arise. We will cover handling objections first and then return to the closing skills.

  7. Handling Objections
  8. In our experience, all possible types of customer objections to a sales offering fit into one of four categories: skepticism, indifference, misunderstanding, or drawback.

    Skepticism means the customer does not believe the seller’s claims about the product or service. The handling skill would include probing to determine the source of the skepticism. Once the source is identified, the seller may be able to offer some form of proof of the claims, such as research findings, third-party authoritative articles, or customer testimonials. This requires the seller to anticipate possible sources of skepticism and prepare valid proofs ahead of time.

    Indifference means that the customer is exhibiting no interest in what is being offered. It does not matter what the product or service delivers in benefits because the customer does not perceive any need for that benefit. The sales response is two-fold: First, remind the customer of other needs and their associated benefits that have already been confirmed and supported during the interaction. Second, try to uncover hidden needs that have not yet surfaced by probing. Perhaps the customer does not recognize what the product or service can do and may actually have some needs that have not yet occurred to them.

    After reviewing any newly confirmed needs and supporting them with benefit statements, the sales approach is to probe for additional needs by asking the customer to provide more information about their operation or processes. When the review is complete, if new needs are supported, the seller can return to the trial close. On the other hand, if no needs have been confirmed or supported, then the prospect is not a potential customer and the seller can stop wasting time and look for a new prospect.

    When a misunderstanding occurs between customer and seller, the basic handling step is to probe to discover the root cause. The misunderstanding can usually be clarified and resolved through discussion. Sometimes the misunderstanding comes from an uncovered need; when the need is revealed, the seller can support it with a benefit statement and move back to the trial close.

    A drawback is the toughest objection to handle because it usually means there is some customer need that cannot be supported with benefits from the product or service being offered. In this case, the seller simply cannot meet the need. The only way to overcome a drawback is to support enough other needs to overcome the impact of the drawback. The sales response is to confirm previously supported needs to remind the customer of the other benefits of the sales offering. The seller can also probe for any hidden needs that can be supported.

    Once enough benefits have been accepted that the customer accepts the drawback due to the other benefits of a product or service, the seller can return to the close.

  9. Trial Close
  10. When a customer seems to be giving buying signals, a seller can verify agreement using trial close techniques, for example, asking “Do you see any reason we can’t move to the next step?”

    If any customer stalls are encountered, a seller should execute the 3 steps to commitment strategy:

    1. Get the customer saying yes by reviewing each of the needs that have already been discussed and asking for agreement that the customer expressed that need.
    2. Keep the customer saying yes by confirming acceptance of each benefit that has already been stated in support of each of the needs.
    3. Help the customer visualize the benefits of using the product or service being offered. If all responses are positive, continue to the close.

    If the customer raises any objections to continuing during the trial close, the seller should execute the appropriate handling skill based on the type of objection raised.

    At any time in the sales interaction, if the customer signals a readiness to buy or move to the next level, it should not be ignored by the seller. Do not talk yourself out of a sale! When there is clear consensus to move to an agreement on next steps, the seller should move to the close.

  11. Closing
  12. Closing is really just reaching agreement on what will be done next. If there has been no trial close, the seller may use the 3 steps to commitment strategy described above to review the needs and benefits of the offering. Then the seller can outline the next steps in placing an order, making the arrangements for delivery of the product, or scheduling the offered service. These agreements should address when, where, and by whom next steps will be taken. Next steps might be setting a follow-up appointment or executing a buy order or similar interaction.

    For more information or assistance with these and similar subjects we recommend one of three options:

    1. Register to attend the NaperLaunch Academy Workshop Series.
    2. Arrange to meet with a NaperLaunch coach.
    3. Arrange to meet with a business librarian.

For more information, titles on this subject available at Naperville Public Library include the following:

Little Red Book of Selling
Value-Added Selling
Secrets of Question Based Selling
Sales Bible
Monday, March 22, 2021 - 08:15